Every year about this time, I get a lot of questions about deducting sales tax paid versus state and local income tax paid on your federal income taxes. Mostly, this comes up because your pockets are stuffed with receipts and you’re wondering whether you should keep them.
First, the important part: this option has been extended through 2007.
Here’s what to consider:
1, If you live in a state with a relatively high state income tax like Minnesota, North Carolina or Wisconsin, you’ll almost always choose the option to deduct your state income tax as opposed to your state sales tax. Of course, that depends on your spending habits.
2, If you live in a state with no state income tax, clearly you are going to choose the option to deduct your sales tax. Those states include Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming.
3, Everyone else has to do the math.
You can use the IRS sales tax calculator to figure your average sales tax expended – or you can actually tally your receipts to make the determination.
When you use the optional general sales tax tables, which is what the calculator figures for you, no receipts are required. The IRS just uses the average spending in your geographic area to figure the tax. You can add the tax on big purchases such as a car or home renovation to the total to figure your tax.
In Philadelphia, where I live, sales tax is 7% – that’s 6% for Pennsylvania and an extra 1% tacked on by the City because… well, why not? State and local taxes on income are much higher, believe it or not. While the state of Pennsylvania is just over 3%, Philadelphia likes to ramp up our taxes by almost another 5%.
Since the numbers are nearly the same, it doesn’t take a genius to realize that you’d have to spend roughly the amount that you make in order to hit the equilibrium. Clearly, that’s not the norm, so I decided to figure the difference between the sales tax using the IRS calculator and state and local income taxes paid. I used $100,000 only because it’s a nice round number. And for my experiment, I also assumed two exemptions (a typical married couple). According to the calculator, the sales tax deduction using the tables would be $1,056. The income tax for PA for the same amount would be approximately $3,000 and the Philadelphia tax would be approximately $5,000. Clearly, in this case, you would opt for the state and local income tax deduction (I always do).
But that “special items” exception keeps things interesting. If you do significant spending in your state during the year, you actually get a tax break – for shopping! Oh yeah.
So in the interest of helping hubby out with his end of the year tax planning, I would suggest that if we used the experimental numbers (which don’t really apply to us for a number of reasons, not the least of which is that we have five exemptions – and if I count my daughter’s imaginary friend who has been destroying our house, we qualify for six), the following would apply: the difference between the sales tax as calculated by the feds and the income tax works out to about $7,000. At a sales tax rate of 7%, this means that we’d need to spend more than $100,000 in order to benefit from this tax incentive – since that’s clearly what it is, an incentive. Why let it go to waste?
I have to keep it both local and subject to sales tax. Hmm. That means no clothing or food – both are exempt in Pennsylvania. So what about:
* The Mini Cooper that I have my eye on is about $37k complete. I know, a little high. But it has GPS. And a girl needs her GPS.
* Improvements to the kitchen will run about $40k, if we play our cards right (let’s not be extravagant). And I need a new dishwasher anyway.
* iMac with printer – about $2800
* iPhone – about $400
* Mac laptop – about $2500
* Canon digital camcorder – about $2800
* New Tiffany’s charm bracelet with charms – about $1500
* Prada bag and new shoes – about $1100
* Master bedroom suite – about $7000, inclusive – after all, my old IKEA bed is wearing on me
* Lots and lots of new plants and hardscaping materials, since I’m a gardening junkie – about $5000
And just like that, I’ve saved us a whole lot of cash!*
For more information about taking state and local sales tax as a deduction versus income tax, see IRS Pub 600.
*Yes, the spending part is meant to be tongue in cheek. And yes, I realize that spending money just in order to get a tax deduction won’t actually save us any money. And yes, I understand that some of the spending options are really extravagant. It’s merely to prove a point.